It is tax time in the U.S., and tax time is a good time to do your annual retirement investments and budget review. You should do such a review once a year. The following is a step-by-step guide for doing such a review. This guide assumes you are already retired. There are 12 steps below. Steps 7-12 are only or may only be applicable if you are already retired. Steps 1-6 are always applicable.
This guide is only applicable to your retirement investments. Additional investments that are not necessary to maintaining your retirement lifestyle throughout your remaining potential lifespan are speculative investments. Your speculative investments should be reviewed separately from your retirement investments and budget. This guide assumes you own a house you live in, and you will continue to live in this house, or you are renting. This being the case, the house, if you own one, is not listed as an investment.
If all of your retirement investments are via a single institution, you may be able to do the process described below well without creating some of the spreadsheets described. Even if you are not interested in creating any of the spreadsheets described below, it is still good to understand the review process described.
1. Do your taxes for the prior year. In doing your taxes for the prior year first, you may acquire a better understanding of what your taxes will be like in subsequent years. You will need an understanding of what your taxes will be like in subsequent years later in the review process. (See steps 5 and 12, as tax implications may alter your investment strategy and taxes are one of your budget expenses.)
2. Create a spreadsheet showing your retirement investment amounts as of last year’s review after final reallocation (See steps 5 and 6.), if you do not already have one. The following is a sample layout you can use. This layout illustrates the level of detail you should have. To the extent you can summarize instead of listing individual holdings and still do the review well, summarize.
|John’s Retirement Investments as of About x/xx/12|
|Type||Symbol||Provider||Description||Entity 1||Entity 1 – IRA||Entity 2||Total||%s|
|Individual Muni Bonds||8 Investment-Grade Bonds||$183,750||$183,750||50.00%|
|Individual Corporate Bonds||7 Investment-Grade Bonds||$160,781||$160,781||43.75%|
|CD||Maturing on x/xx/17||$22,969||$22,969||6.25%|
|Type||Symbol||Provider||Description||Entity 1||Entity 1 – IRA||Entity 2||Total||%s|
|ETF||SCHB||Schwab||U.S. – Largest 2500||$128,625||$128,625||35.00%|
|ETF||VO||Vanguard||U.S. – Larger Midcap||$73,500||$73,500||20.00%|
|ETF||SCHM||Schwab||U.S. – 501-1000 Largest||$27,563||$27,563||$55,125||15.00%|
|ETF||SCHF||Schwab||Foreign Developed Country – Larger||$44,100||$44,100||12.00%|
|ETF||SCHC||Schwab||Foreign Developed Country – Smaller||$44,100||$44,100||12.00%|
|Type||Description||Entity 1||Entity 1 – IRA||Entity 2||Total||%s|
|Notes: Entity – The name of the institution where the account resides (e.g., Bank of America, Merrill Lynch, Charles Schwab, or TreasuryDirect). If you have an IRA account along with a regular account at the same institution, create separate columns for the regular and IRA accounts.||%s|
3. Create a spreadsheet showing your retirement investment amounts as of now. Use the same format you used for the prior spreadsheet. If you added a new investment during the year, add a row for the investment on this spreadsheet and the prior spreadsheet. This will make the next spreadsheet you are going to create easier to create.
4. Create a spreadsheet showing the percentage increase or decrease in your investments during the 1-year time period. Use the same format you used for the prior spreadsheet, except you will not need any of the %s fields. This spreadsheet will only be populated with percentages. For each field where you have a non-zero dollar amount on either the 1st or 2nd spreadsheet (This is the 3rd spreadsheet.), enter a formula equivalent to 2nd spreadsheet number divided by 1st spreadsheet number then minus 1.
This spreadsheet will enable or help you to review the performance of your investments during the year. It will show you your gain or loss for each investment, each investment category, and your entire retirement portfolio. If you did not reinvest interest or dividends in the same investment, the percentage shown will only be your gain or loss in principal. If you bought more of an investment or sold some of an investment, the percentage shown will reflect this. You can use colored fonts or cell shadings to highlight which investments had reinvested dividends, etc.; and you can use the Notes field to remind yourself which colors signify what. If you want further insight into how your investments performed, you can use additional sources or make additional calculations.
5. Make your investment reallocation decisions. The 2nd spreadsheet shows you your current investment amounts and percentages. Is your fixed-income to stocks balance still appropriate given your age and current fixed-income versus stock investment opportunities? Are your fixed-income investments appropriately balanced and sufficiently diversified within themselves? Are your stock investments appropriately balanced and sufficiently diversified within themselves? Are you maintaining more cash than you should? Do you have any strategic investment shifts you want to make during your reallocation? These are the kind of questions you should be asking yourself at this point.
Do not attempt to be too perfect in rebalancing your portfolio. Small adjustments can be unwarranted given the time and expense associated with making the adjustments.
6. Create a spreadsheet showing what your portfolio will look like after you reallocate. Use the same format you used for the 1st and 2nd spreadsheets to create this spreadsheet. Add a new row if, upon reallocation, you will make an investment that is different than the investments you already have. This spreadsheet―the 4th spreadsheet―is unnecessary if you are not going to make any allocation changes. If you are not going to make any allocation changes, you can simply copy the 2nd spreadsheet and rename it. This spreadsheet will show what your portfolio will look like after you make any sales or purchases for rebalancing or strategic purposes. You can use colored fonts or cell shadings to highlight which investments will be shrunk or increased in size, etc.
7. Create a spreadsheet showing your annual interest and dividend percentages. Use the same format you used for the 1st, 2nd, and 4th spreadsheets, except you will not need any of the %s fields or the Total column, which is the second column from the right. Also, the Subtotals rows and the Totals row near the bottom of the spreadsheet will be left empty. This spreadsheet is used to determine your projected investment cash-flow-in for the next year. On this spreadsheet―the 5th spreadsheet, you do not care what an investment’s true yield or projected total return is. Your only concern is cash flow to you.
Good numbers to enter on this spreadsheet include distribution yields for funds, interest rates for individual bonds or CDs, and dividend yields for individual stocks. Be careful about using distribution yields or dividend yields that only reflect a single distribution or a very small number of distributions, as these yields can be deceptive.
8. Create a spreadsheet showing your projected interest and dividend amounts, and other projected investment cash-flow-in amounts, for the coming year. Use the same format you used for the 1st, 2nd, and 4th spreadsheets, except you will not need the %s fields in the lower right corner. Instead of having the %s in this section, use this section to total the interest and dividend amounts that will be usable by you during the next year. IRA account interest or dividends will not be usable. CD interest that is not distributed to you will not be usable. Any dividends you choose to reinvest will not be usable.
In the lower right corner section, also create fields for any other investment cash-flow-in amounts you will have during the year that you will not reinvest. For example, you may have an IRA distribution during the year; you may have some U.S. savings bonds you will cash in during the year; or you may plan to spend part of a maturing bond principal return you will receive. Sum all investment cash-flow-in amounts you will not reinvest to get a total.
On this spreadsheet―the 6th spreadsheet, for each field where you have a percentage on the prior spreadsheet (the 5th spreadsheet), enter a formula equivalent to the 4th spreadsheet number times the 5th spreadsheet number. The remaining %s fields and the Total, Subtotals, and Totals fields will function well as is and do not need to be revised. You can use colored fonts or cell shadings and the Notes field to remind yourself why you included some amounts as cash-flow-in but not others.
9. Create a spreadsheet showing your projected annual investment earnings percentages. Use the same format you used for the 5th spreadsheet. On this spreadsheet―the 7th spreadsheet, you will enter the percentage total gain projected for each investment. If you project a loss for an investment, you should probably sell the investment.
For CDs, savings accounts, and checking accounts, the interest rate is a good number to use. If any of these accounts have costs associated with them, you can include these costs in the budget you will create in a later step. (See step 12.)
For individual bonds, collections of individual bonds, and bond funds, YTW (yield to worst) is a very important figure. YTM (yield to maturity) is a good substitute if the bond or bonds cannot be called or the like. Some bond types default sometimes. If the bond type defaults sometimes, subtract a percentage that represents an average default loss experience for the type, years to maturity, and grade of the bond(s) from the YTW or YTM. (This topic warrants a separate article[s], and I have already written about this some.) If it is a bond fund, also subtract the fund expense ratio. If it is a bond fund that does not hold its bonds to maturity and, then, provide the principal in cash to shareholders (i.e., what I have named a TMTC [to-maturity-then-cash] fund), subtract or add a factor for share price loss or gain due to interest rate change.
For individual stocks, collections of individual stocks, or stock funds, bear in mind that the CAGR (compound annual growth rate) for the S&P 500 was 8.92%, including dividends, from 1871 thru 2012 and, less inflation, this figure was 6.71% (so average U.S. inflation was 2.21%). The Fed board members and bank presidents recently projected inflation of about 1.5% from the 4th quarter of 2012 to the 4th quarter of 2013 and 1.75% from the 4th quarter of 2013 to the 4th quarter of 2014. Beginning from 4/1/13, a typical S&P 500 return rate for the next year would be about 8.3% (i.e., 6.71% plus 1.59% for projected inflation).
A very long story made short, I think that midcap stocks will perform slightly better than the S&P 500 going forward. I think that small cap stocks may only do about as well as the S&P 500 going forward. I think that U.S stocks are, now, slightly more expensive, based on P/E (price/earnings) ratio, than is long-term-historically usual; but this is of no concern given how low U.S. interest rates currently are. Foreign stocks are, currently, generally less expensive than U.S. stocks. (These topics warrant a separate article[s], and I have already written about this some.) Whatever projected earnings figures you decide to use for stocks, be certain to include dividends and subtract the fund expense ratio if it is a stock fund.
10. Create a spreadsheet showing your projected earnings amounts for the coming year. Use the same format you used for the 1st, 2nd, and 4th spreadsheets. On this (the 8th) spreadsheet, for each field where you have a percentage on the prior spreadsheet (the 7th spreadsheet), enter a formula equivalent to the 4th spreadsheet number times the 7th spreadsheet number. The %s fields and the Total, Subtotals, and Totals fields will function well as is and do not need to be revised. By dividing the all-encompassing total projected earnings amount on this spreadsheet by the amount in the corresponding field on the 4th spreadsheet, you get a projected earnings percentage for your portfolio as a whole. You should add a field for this statistic in the lower right section of the spreadsheet.
11. Calculate the inflation-adjusted amount you can spend each year so you have zero dollars remaining upon the oldest age you may live to. This step is complex and warrants a separate article(s); and this is a step where many retirees take an inferior, but simpler, approach instead. Many retirees live off of their investment cash-flow-in, social security, and any other income they may have, versus making the best appropriate investments and selling some stock or whatever as warranted. These retirees tend to place too great of an emphasis on distribution rates like interest rates and stock dividend yields.
The best annual spend amount is calculable in a spreadsheet if you know your beginning principal (which is the all-encompassing total amount in the 2nd and 4th spreadsheets), the projected earnings percentage for your portfolio as a whole (which needs to be revised for, some at least, future years), your social security and any other future non-investment income, and likely future rates of inflation. A typical oldest potential age people use is 110.
12. Create a budget spreadsheet for the coming year. This budget spreadsheet will have a section covering all of your expenses, which will be totaled to provide an annual amount. Then, it will have a row for your annual spend amount. Then, it will have a row where you will subtract your annual expenses from your annual spend amount. This is your play money for the year. Then, it will have a row for your projected annual investment cash-flow-in amount. Then, it will have a row for your annual social security. Then, it will have a row(s) for any other income you may have during the year. Then, it will have a row wherein you total the preceding cash-flow-in rows. This is your total cash-flow-in for the year.
If your cash-flow-in for the year is significantly less than your annual spend amount, and you intend to spend all of your annual spend amount, you need to leave some extra cash in your savings account and/or sell something soon and/or during the year so you have sufficient cash-flow-in. If your cash-flow-in for the year is significantly greater than your annual spend amount, you should consider making additional investments as the year progresses. The review process can become circular at this point because it may be that you should now make some revisions to your reallocation spreadsheet, which will change some of the calculations you did previously. My experience is that, once you circle back through a couple of times, you will see that you are close enough to the correct figures that no more effort is warranted.
This review process requires a good amount of effort the first time you do it. In subsequent years, it is much easier to perform. If you perform this review process each year, you will have a firm grasp and better control of your retirement situation.
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